Another Random Thought about Obama’s Tax Plans

One of the features of the U.S. income tax system is that despite very considerable variation in the cost of living across regions the tax rate schedule is uniform across the country. Consider my favorite two states: Texas and New Jersey (how many people can say that?). Based on state level estimates of cost of living, the same consumption bundle costs 35% more in New Jersey than it does in Texas. Nevertheless a New Jerseyan and a Texan with the same dollar income will pay the same dollar amount in taxes. But the Texan will pay 35% less in terms of local consumption. Consequently, the tax system violates an important principle: two people with the same ability to pay should pay the same taxes.

Of course, there are a lot of factors that offset these differences. First, unlike politics, not all consumption is local. Both the New Jerseyan and the Texan pay the same for their EuroDisney vacation. But enough consumption (especially housing) is local so that large differences remain.

Within the tax code itself, the major offset to these differences has been on the deduction side. New Jersey housing costs more so that the New Jersayan has a bigger mortgage deduction than a Texan. It costs more to sustain her local charities so the New Jerseyan may give more to charity. Her state government costs more for a given set of services so she pays more state taxes and gets a larger deduction.

But with its phase outs of itemized deductions, the Obama tax plan moves in the direction of exacerbating the regional differences in “real” tax liabilities. One of the ironies (that soon may not be lost on his administration) is that many of the states that are most affected by this inequity are those that strongly support his election.

Note that your statement “Consequently, the tax system violates an important principle: two people with the same ability to pay should pay the same taxes” is a concept akin to me saying “I should be able to lose 20 pounds”. I can say these things but when I get near the fridge I do just the opposite.

We have long left the ability to pay principle behind. By looking at the disparate approaches in different jurisdictions (income taxes, property taxes and sales & use taxes, etc) one can clearly note that there is little relationship between the ability to pay and the amount of payment. Even something as simple as municipal bond interest (tax free in certain jurisdictions) challenges any notion of the principle.